U.K. regulator turns to behavioral economics to detect fraud

FSA to split next year

Duke University’s Ariely, the author of the book “The (Honest) Truth About Dishonesty” and others on behavioral economics, conducts honesty experiments. In one he tempted participants to cheat in a series of tests by offering economic rewards, and monitoring their responses. He found that wrongdoing increased if something other than money was at stake -- in one case vouchers, though Ariely says the same principle could apply to securities or derivatives. Any cheating in the test made it more likely others would do the same, he said.

“The moment some bank starts playing with Libor or whatever it is, other banks think this is OK as well,” Ariely said, referring to allegations a group of banks including Royal Bank of Scotland Group Plc and Barclays Plc profited from manipulating the London interbank offered rate. Barclays admitted wrongdoing and paid 290 million pounds in fines.

For Ariely, his research shows that regulators are taking the wrong approach by focusing on punishing wrongdoing after the event. Rather they should be encouraging people to take the right path with clear regulations, ethical training and proper incentives.

“It’s not about bad people,” he said. “It’s about helping good people stay good.”